My PPP Loan Was Approved – What Now?
The number of approved small business Paycheck Protection Program (PPP) loans has soared in the past week, and as of Thursday, April 16, funding was completely exhausted. The PPP loan program offers low-interest, forgivable loans to small businesses and nonprofits through lending institutions. Since its enactment, the CARES Act has provided $349 billion to applicants.
For those who have followed our guidance over the past several weeks, you are likely shifting from questions regarding loan amount, eligibility and eligible proceeds to questions about loan forgiveness. We now hope to begin answering the next question on everyone’s mind – I received my loan, now what?
What are the terms of my Paycheck Protection Loan?
The terms of your loan will be stated on the lending documents. Generally, you should see an interest rate of 1.0% with a loan term of 24 months.
When is my first payment due?
The payments should be deferred for six months. Thus, your first payment should not be due until six months after the date of your first loan fund disbursement.
How do I record this loan on my financials?
The loan should be recorded on your balance sheet. As with all debt, the proceeds will be recorded to cash, and the loan amount will be a liability. The current portion of the debt should be recorded as a current liability, and the portion of debt extending beyond one year should be recorded as a non-current liability. Since not all companies split liabilities on an interim basis, this reclassification can be done as part of your year-end closing adjustments.
SBA Forgiveable Loan $XXX,XXX.XX
To record the receipt of loan proceeds and establish liability.
Will the loan require financial statement disclosure in the footnotes?
The loan issuance and forgiveness process will likely occur in its entirety during the 2020 reporting period for a calendar year business. For this reason, most companies will not need year-end footnote disclosures. However, for fiscal companies whose year-end straddles this period or for companies who disclose footnotes quarterly, the standard debt footnote requirements will apply.
The company should also consider relevant footnote disclosures and subsequent event disclosures as it relates to the financial impacts of COVID-19.
Does interest accrue on this loan?
Yes, interest will accrue on the outstanding loan balance beginning with the date of loan issuance. The borrower should review the loan document to understand how the lender will calculate interest accrual as not all lenders will have the same calculation. You may see a daily interest rate calculation in your lending documents as well as the use of a 360-day year vs. a simple interest calculation with a 365-day year. In general, the monthly interest rate will be 0.083%, approximately (1.0% / 12 months).
How do I record the interest accrual?
The interest accrual will need to be recorded as part of the month-end closing process. The interest will be expensed as incurred and accrued on the balance sheet.
Interest Expense $X,XXX.XX
Accrued Interest $X,XXX.XX
To record the monthly interest accrual and expense.
Who will forgive my loan?
The borrower will apply for forgiveness directly with their lender. The process will vary based on the lender, so we encourage all borrowers to maintain communications with their lender to ensure lender requirements are satisfied.
How long does it take for forgiveness?
The SBA is providing lenders 60 days to approve requests for forgiveness. The SBA will subsequently reimburse the lender within 30 days from the issuance of forgiveness.
When should I request forgiveness?
There is no “due date” for forgiveness; however, we recommend filing promptly after the end of the eight-week forgiveness period. As discussed above, the lender has 60 days to approve the request, which, when coupled with the eight-week forgiveness period, utilizes four of the six month deferral period. Thus, the process only has two months of leeway before the expiration of the deferral period. While this is a seemingly large amount of time, the SBA has issued over two million loans, all of which have forgiveness periods ending within two weeks of one another. We expect the process to be lengthy and complicated; therefore, we recommend starting early. Also, any accrued interest will likely become due if the loan is not forgiven or repaid in full before the end of the deferral period.
When does the loan forgiveness period start?
The loan forgiveness eligibility “period” begins with the funding of loan proceeds and ends eight weeks later. The lender has 10 days from approval to start disbursing funds to an applicant.
What expenses are eligible for forgiveness?
Generally, the proceeds of the loan can be used for the following:
- Payroll and payroll support costs
- Compensation in the form of salary, wages, commissions, or similar compensation
- Cash tips or the equivalent (based on employer records of past tips or, in the absence of such documents, a reasonable, good-faith employer estimate)
- Payment for vacation, parental, family, medical, or sick leave
- Allowance for separation or dismissal
- Payment for the provision of employee benefits consisting of group health care coverage, including insurance premiums, and retirement
- Payment of state and local taxes assessed on the compensation of employees
- Mortgage interest (but not prepayments or principal payments) on obligations in place before February 15, 2020
- Rent and utility payments in place before February 15, 2020
- Interest payments on other debt obligations in place before February 15, 2020
- Refinancing an SBA EIDL loan made between January 31, 2020, and April 3, 2020
The Families First Coronavirus Response Act allowed taxpayers to offset payments made for COVID-19 related emergency medical leave and emergency sick leave against payroll taxes. The amounts for parental, family and medical leave listed above need to be exclusive of any wages submitted for tax credits.
Are there any limits to the eligible costs?
Yes, compensation is limited to $100,000 per employee. Further, non-payroll costs cannot include payments on principal, and expenses in periods beyond the forgiveness period cannot be accelerated or prepaid.
How much of my loan will be eligible for forgiveness?
If used on eligible expenses, the forgiveness amount will be the amount spent during the eight-week forgiveness period, capped by the principal amount of the loan plus any accrued interest.
How do I calculate base period employee headcount?
The average full-time equivalent (FTE) period for purposes of the loan forgiveness is either January and February 2020 or February 15 - June 30, 2019. We recommend borrowers calculate the headcount for both periods and elect the lower base.
How do I calculate base period payroll costs?
The base period costs were previously disclosed during the application process. For most applicants, the base period payroll costs were for the calendar year ended December 31, 2019.
What would cause my loan forgiveness to be reduced?
Potential reductions to forgiveness include employee headcount reductions and reductions in payroll costs. The SBA has also implemented a 25% limit on using the proceeds for non-payroll expenses (mortgage interest, rent and utilities, and interest on debt obligations).
The borrower may see a reduction in available forgiveness by not reestablishing FTEs by June 30, 2020. The reduced headcount will likely cause a percentage reduction in loan forgiveness. For example, if a borrower averaged 200 FTEs during the base period (see above) but only employed 150 FTEs during the eight-week forgiveness period, they have reduced headcount. The borrower will have until June 30, 2020, to restore the 50 FTEs or potentially have their forgiveness amount decreased by 25% (150 – 200 / 200).
The borrower may also see a reduction in available forgiveness by reducing overall payroll by more than 25%. It is our interpretation that forgiveness will be reduced to the extent payroll is reduced by more than 25%. This interpretation is subject to change based on future guidance from the SBA. The reduction in wages will result in a dollar-for-dollar reduction in the forgiveness amount. For example, if a borrower had $3,000,000 of payroll costs in 2019, and annualized salaries paid during the eight-week forgiveness period were only $1,500,000, the company would lose $750,000 ($3,000,000 x 75% = $2,250,000 less $1,500,000) in available forgiveness. The calculation is considered at the individual employee level, and employees earning more than $100,000 are excluded from this test.
What can I do to ensure I can spend 75% of my loan on the payroll component?
We recommend borrowers calculate a reasonable amount of forgiveness to ensure compliance with the 75% | 25% split of payroll and non-payroll expenses, respectively. The calculation will allow borrowers to understand if this rule will be an issue going forward.
For the estimate, a borrower can use a comparative period in the prior year to estimate non-payroll costs (utilities, rent, interest, etc.) If this amount is multiplied by three, the borrower will have the amount of money necessary to spend in the eight weeks to have all non-payroll costs forgiven. If not, the borrower will likely be in a position of reduced forgiveness. For example, if non-payroll costs are estimated at $100 during the forgiveness period, then the borrower needs to determine if $300 or more is a reasonable estimate of payroll costs. Keep in mind that borrowers may receive more proceeds than can be spent during the forgiveness period. The inverse may also be accurate; actual costs incurred may exceed the principal amount of the loan. In either case, proper forecasting and modeling can help borrowers optimize loan forgiveness. Please consult with your Brown Smith Wallace advisor for assistance.
What if I have made headcount reductions or payroll cuts?
An exemption exists for any borrower who has made headcount or salary reductions between February 15, 2020, and April 26, 2020. Generally, employers will have until June 30, 2020, to restore headcount and payroll levels. The amount of loan forgiveness will be calculated without regard to changes made during this period if restored by the end of the covered period.
Do I have to rehire the same people?
No, the FTE count is not on an employee-by-employee basis. If a borrower has an employee or employees who leave the company for any reason, the borrower would need to refill the position(s) before June 30, 2020, to prevent a reduction in headcount.
How should I document loan uses for purposes of forgiveness?
Documentation will be submitted to the lender servicing the covered loan. The documentation should include information to verify the number of full-time equivalent employees on payroll and the pay rates for the periods covered, payments on covered mortgage obligations, payments on covered lease obligations, payments on covered utility payments and payments of interest on other debt obligations, as well as a certification from a representative of the eligible recipient.
On a lender-by-lender basis, there may be other documentation deemed necessary to verify eligible expenditures. We suggest retaining all source documents, including payroll registers, bank statements, ledger details, invoices for mortgage interest, rental and lease agreements or monthly invoices, utility bills, invoices for interest on debt obligations, etc.
Should I maintain a separate account for loan proceeds?
Ideally, yes. We recommend the use of a different bank account for the PPP loan proceeds. The bank statement can be used as supporting documentation for the forgiveness application. A borrower can also use the activity to institute a weekly routine for gathering source documentation for any outflows from the account.
We realize this is not practical for all borrowers and want to stress that the documentation component is more important than the actual separation of funds.
When the loan is forgiven, do I adjust my financials?
Loan forgiveness will require the recognition of debt extinguishment income as well as a reduction in the outstanding loan balance. The amount of extinguishment income will include both principal and accrued interest, so it is essential to reverse the interest accrual in a manner consistent with how it was initially recorded.
SBA Forgiveable Loan $XXX,XXX.XX
Accrued Interest $X,XXX.XX
Gain on Debt Extinguishment $XXX,XXX.XX
To record debt forgiveness.
It is crucial to record the income as other income, below the line from operating income, to prevent an overstatement of operating income.
What will my auditor need?
Forgiveness must be evidenced by a letter of reprieve from the lender. The auditor will likely request this document as part of their audit or review process.
Is the interest forgiven too?
Yes, the interest accrued on the portion of the loan that has been forgiven, will also be included.
What if I have a balance left on my loan?
Any monies remaining from the loan after forgiveness will become a debt obligation of the borrower. The accrued interest will either become due along with the first payment or added to to the outstanding balance of the loan and termed over the remaining months. The borrower should check the loan documents to understand the treatment.
The borrower also has the option to repay the loan amounts if any remain. Our suggestion to use a separate account should make this accounting easier.
SBA Forgiveable Loan $X,XXX.XX
Accrued Interest $X,XXX.XX
To record the repayment of the loan, if done in full.
SBA Forgiveable Loan $X,XXX.XX
Accrued Interest $X,XXX.XX
To record the recurring monthly entry if the loan is retained.
What should I record on my federal tax return?
The loan forgiveness does not create cancellation of indebtedness income, which is typically included in taxable income. Since the loan forgiveness will be considered financial income, a permanent difference will need to be recorded on the tax return to adjust taxable income. For borrowers who record a tax provision, this will need to be recorded in the financial statements.
The tax implications of Internal Revenue Code (IRC) §265 have not yet been determined. The legislation has deemed the amounts to be excluded from taxable income; however, there is no legislation addressing the deductions associated with uses of tax-free income. Under IRC §265, expenses relating to tax-exempt income are disallowed. If no deduction is allowed, then the borrower receives no tax benefit since it has no income from the forgiveness and no deduction for the expenses. We believe this is contrary to the intent of the statute, and we are expecting clarification.
Will the states tax forgiveness?
State income tax is a patchwork of policies ranging from full conformity with the IRC to a combination of federal compliance and state-specific policies.
Many states have what is referred to as “static” conformity. These states conform with large amounts of the IRC, but not necessarily all the current year legislative amendments. The compliance typically exists as of a specific date, often the end of the previous calendar year. Other states have “rolling” conformity. These states conform fully with the existing IRC with all amendments. These states will not tax the forgiveness of federal loans under the PPP unless lawmakers in those states adopt a law expressly doing so. But with static conformity states, treatment will depend on if and when the state updates their conformity. A map of compliance can be found here.
We realize borrowers still have many questions left unanswered right now. The SBA intends to release further guidance on loan forgiveness and these potential reducers by April 26, 2020. We believe documentation and developing internal processes to track expenditures of loan proceeds should be the priority until further guidance is released.
Brown Smith Wallace provides this material for informational purposes only. The content presented herein is general and is not intended to be advice. Nothing herein should be relied upon or used without consulting an advisor to consider your specific circumstances, changes to applicable laws, rules and regulations and other legal issues. Any U.S. federal tax advice contained herein is not intended to be used to avoid penalties under U.S. federal tax law.